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How Video Game Developers Are Extending Franchise Value

Dylan Lewis and David Kretzmann take a look at how the gaming industry’s new business model extends franchise value and normalizes cash flow.

The video gaming industry's business model isn't what it was a decade ago.

One obvious way a video game company can make major profits is to build a hit franchise. Just as Hollywood movie studios know that the right sequel can provide a guaranteed box office payday, the same can be true when it comes to video games.

In this clip from from The Motley Fool's Industry Focus: Tech podcast, Dylan Lewis and David Kretzmann talk about why many video game publishers have shifted to an online purchase-based model, and how they are managing their franchises. They also look at how companies like Activision Blizzard(NASDAQ:ATVI) are starting to use movies and TV shows to extend the value of their intellectual property.

This podcast was recorded on June 10, 2016.

Dylan Lewis: One of the other major catalysts I see for both of these companies is the idea of extending their existing franchises, possibly even licensing out their franchises. We've definitely seen Activision Blizzard do this a bit in the past with World of Warcraft. It sounds like their strategy might be shifting a little bit with that.

David Kretzmann: Yeah, so backing up a little bit, 10 years ago, when you bought a game, you would pick up the case off the shelf. You would install it on your computer, or your console, and then you would play it maybe five or six months. You get tired of the game, you move on. Now, both for Activision and Electronic Arts(NASDAQ:EA), they make more than half their revenue through digital sales. Rather than going to the store and buying the copy, oftentimes you can just download a game online onto your console, onto your PC, play the game.

The life of these franchises is now being extended thanks to these digital purchases, or micro transactions within the game. It's no longer just a case where a customer is making a one-time purchase of a game. You might buy the game, and then after you accomplish so much within the game, suddenly you have the opportunity to pay maybe $3 to open up another map in the game you're playing, or maybe you want to buy a certain jersey for your NBA team, or your FIFA team.

There are all sorts of these different micro transactions. You're seeing, with these video game companies, it's no longer the one-time purchases, but they're stretching out the life of their franchises. It turns out that digital revenue -- it's higher margin for the company. It stabilizes their cash flow production. It's appealing for investors and it's appealing for gamers, too. You're able to really engage with the game in a new way.

You have these companies; Electronic Arts has especially made a concerted effort. They're almost releasing daily, or weekly updates to some of these games, not just on mobile, but on other platforms. The game is really a living entity now. It's not just this one-time thing that you purchase. It's something that you can engage with for a very long time. That's certainly an important shift that's been happening in the space. It's likely to continue going forward.

Lewis: One of the things that we've seen on Activision side, at least, is the idea of these properties having value outside of the game themselves. We look at the World of Warcraft movie which Activision ...

Kretzmann: We'll see how that does. It's coming out.

Lewis: The idea that they are able to take what was a game and was on a gaming platform and bring it out to a mass audience in the form of a movie.

Kretzmann: Right. Video games, up to this point, they have been infamous for not transferring well to the movie screen. In the case of Warcraft, which has received mixed reviews up to this point, that wasn't actually created in-house by Activision. It was licensed out, I believe to Universal.

Similarly, last year Activision actually created a movie and TV production studio. They have a guy heading it up who spent nine years at Disney(NYSE:DIS) as a senior vice president. The guy heading it up, Nick van Dyk I believe is his name. He was a key player at Disney for the acquisitions of Marvel, Pixar, and Lucasfilm.

Activision, they're making an effort again, similar to what they're doing in e-sports, they have a new division for movie and TV production where they're acknowledging that they have this extensive library of intellectual property, and these very vibrant game franchises that have done very well for more than a decade like Warcraft, and Call of Duty.

One of the early projects for this production studio is creating a cinematic universe for Call of Duty. We'll see if this studio can break the curse that's fallen on video games when people try to make a movie out of them. It's a similar approach to what you've seen Disney take. Activision, in a lot of ways, is becoming mini-Disney with what they're doing. They're trying to have the broadcasting platform with e-sports. Obviously they have the games, the core franchises there. Now they're trying to extend those franchises to movies and TV shows.

When you look at Activision, I see them as taking a similar strategy to maybe what Disney was doing 15 years ago. It doesn't mean that Activision will be as successful, or as big as Disney; perhaps one day. I think it's interesting to compare Activision's strategy to what we saw from Disney years, or decades ago.

David Kretzmann owns shares of Activision Blizzard, Electronic Arts, and Walt Disney. Dylan Lewis owns shares of Walt Disney. The Motley Fool owns shares of and recommends Activision Blizzard and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.